Right to Fight Tax Regulations Set for High Court Argument

The U.S. Supreme Court is set to hear a case involving an IRS reporting requirement that observers are closely monitoring for potential broader implications for regulation and enforcement.

Tennessee consulting firm CIC Services LLC wants the court to throw out an IRS reporting requirement that the firm says wasn’t properly issued. But so far the firm has run up against a law known as the Anti-Injunction Act, which two lower courts have said requires the firm to violate the requirement and pay a penalty before it can bring its suit.

The Anti-Injunction Act generally forces a taxpayer to wait to bring lawsuits challenging tax rules until after the taxpayer has actually received an IRS tax bill or paid tax under the rule. The question for CIC Services is whether the act applies to the penalty-backed reporting requirement the firm is challenging.

The Supreme Court is set to hold oral arguments in the case on Tuesday. A win for CIC Services would likely mean taxpayers could target other third-party reporting requirements.

“The resulting litigation could cripple tax administration, said Bryan Camp, a tax professor at the Texas Tech Law School who submitted a brief to the Supreme Court in support of the IRS.

Some have urged the Supreme Court to limit the Anti-Injunction Act in a way that would expose rules and regulations beyond the reporting requirements to quick lawsuits. That could mean more overall lawsuits for Treasury to fight or a more protracted tax collection process.

The Supreme Court is reviewing a 2019 ruling by a three-judge panel of the U.S. Court of Appeals for the Sixth Circuit, which granted the IRS’s motion to dismiss the case. The full Sixth Circuit declined to revisit that ruling in a decision that seven judges disagreed with.

Combating Tax Shelters

The requirement CIC Services is challenging—set in a 2016 IRS notice (Notice 2016-66)—directed those advising on certain micro-captive transactions to report the transactions to the government. These transactions involve small insurance companies that can get a lower tax rate if their income from premiums doesn’t exceed $2.3 million. The IRS believes some of these transactions are vehicles for tax avoidance.

The notice states that material advisers who fail to meet disclosure requirements may be subject to penalties.

CIC Services has argued that even though Congress has labeled these penalties as taxes, they “are several steps removed from the assessment or collection of taxes” covered by the Anti-Injunction Act.

One question raised by the case is whether a win for CIC Services could broadly throw such tax-shelter-targeting reporting requirements in jeopardy. In a third-party brief filed with the Supreme Court in support of the IRS, several former government officials argued that enabling courts to suspend such reporting requirements could introduce various problems, such as IRS non-detection of potential tax shelters and the lapse of time limits for the IRS to assess additional taxes.

Congress made a deliberate decision to label the penalties as “taxes,” a decision that rests within the broader framework the IRS faces in trying to go after tax shelters, according to Daniel Hemel, a tax professor at the University of Chicago Law School and one of the brief’s authors.

“Under petitioner’s theory, Congress gave the IRS an impossible job,” he said.

Examining the Tax Regulation Landscape

While the case directly implicates penalty-backed reporting requirements, some see broader questions for tax regulation. That’s because the Anti-Injunction Act has been interpreted to apply across a wide range of tax rules.

That typically means it can take several years before anyone can mount a challenge, according to Andy Grewal, a tax professor at the University of Iowa’s College of Law.

That delay sets Treasury Department regulation apart from the regulation of other federal agencies. Some argue that disparity is justified because tax revenue funds everything else the government does.

Still, others believe the Anti-Injunction Act insulates too many Treasury actions from early legal challenges that can test their legitimacy.

Hemel argued that allowing for legal review of tax regulations before the regulations are enforced would be a good thing if other changes—like additional funding to the IRS—were also made to protect the work of tax enforcement.

“But keeping everything else as is, and allowing pre-enforcement review of tax regulations, strikes me as a recipe for a return to the bad days of the late 1990s and early 2000s, when you have sophisticated tax shelter promoters helping high-net-worth clients avoid and evade taxes, and the IRS can’t do anything about it,” he said.